1. MERIT PAY
MERIT PAY and Its Effectiveness
By: Stephanie Snyder
Salem International University

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MERIT PAY AND ITS EFFECTIVENESS
At some point in our careers, we’ve had that all too familiar performance appraisal at the
end of the year. They are used to determine whether we receive a monetary bonus, an incentive
bonus, merit pay bonus, or a skills-based bonus. We’ll focus on the merit pay bonus. For the
purposes of this paper, we’ll simply refer to it as merit pay or pay-for-performance. The United
States Department of Labor defines merit pay as “a raise in pay based on a set of criteria set by
the employer” (“Merit Pay,” n.d.). In their book Merit Pay: Linking Pay to Performance in a
Changing World, Heneman and Werner broke merit pay down to three levels, at the basic level,
merit pay is essentially compensation paid to employees for services “rendered,” at the mid-
level, it’s incentive pay, and at the most detailed level, it’s defined as “individual pay increases
based on the rated performance of individual employees in a previous time period” (2005, p. 6).
The US Department of Labor’s definition and Heneman & Werner’s detailed level definition of
merit pay are very similar. In short, merit pay is determined by performance criteria.
Companies believe that a merit pay plan encourages better performance by connecting
performance to pay (Schay and Fisher, 2013, p. 360). The purpose of this paper is to determine
whether or not merit pay is effective. We will learn why companies use merit pay plans, the
effectiveness of merit pay, what can cause merit pay plans to fail, and ways to make it work.
WHY IS MERIT PAY USED
There’s a belief amongst companies that merit pay helps bolster performance. Does it
really? Heneman and Werner believe that there are two theories as to why merit pay may help
with this idea, the psychological theory or the economic theory (2005, p.24). The psychological

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theory tells us that merit pay will work if employees connect pay to performance (Heneman &
Werner, 2005, p. 24). If there’s no connection employees would see no need to improve their
performance. With the economic theory, merit pay is affected by what the economy does so
companies use “opportunity costs” to their advantage (Heneman & Werner, 2005, p. 33). The
psychological theories lend themselves more to the purpose of the paper and will be the only
theories covered because without the connection of pay to performance, an employee’s
motivation is all but lost. But we’ll cover this later.
Psychological Theories
According to Heneman and Werner, the psychological theories associated with merit pay
are the expectancy theory, which is the connection employees tie to productivity (2005, p.25);
the reinforcement theory, which is the connections between repeated performance and it’s
outcomes or “consequences” (2005, p. 27); and the equity theory, which “proposes that
individuals compare the ratios of their inputs (performance) and outputs (rewards) (Schay &
Fisher, 2013, p. 361). You can see how these all tie into the general assumption that merit pay is
a motivational factor to improved performance.
WHEN MERIT PAY IS EFFECTIVE
Merit pay is most effective when an employee can tie pay to performance as stated above.
It is also most effective when performance appraisals are clearly understood that they are used to
determine merit pay. According to Snell and Bolander, such appraisals are “part of an
organization’s measurement process” (2013, p. 346). What this means is that they are used

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to measure an employee’s performance. We can look at appraisals as being evaluations of how
well employee’s perform on the job. One way to see how both performance appraisals and merit
pay are effective is to evaluate “employee reaction to the system” (McKinney, Mulvaney, and
Grodsky, 2013, p.473). This is a win-win situation for employers if they pay attention to it and
not ignore it. A second way of ensuring that pay-for-performance is effective is to align it
company’s objectives. In Managing Human Resources, Snell and Bohlander state this can be
achieved by “identifying important organizational metrics” and “customizing an incentive plan”
(2013, p. 436). The first being a performance measurement while the second being an output
and reward measurement (Snell & Bohlander, 2013, p. 436).
WHEN MERIT PAY FAILS
We know that merit pay is most effective when an employee can tie pay to performance.
Then the opposite can be said for when it fails. If there’s no connection, then it would be hard
for employees to distinguish how their pay is tied to performance. Merit pay also fails when
employers rely on the assumption that it will motivate employees. Jeffrey Pfeffer, a professor of
organizational behavior at Stanford University’s School of Business, states “individual pay for
performance does not improve organizational performance except in very limited cases” (as cited
in Hansen, 2008). Think of it like this, what works for some may not work for others. Merit pay
fails when employees lose interest in the work that they already paid to perform (Heneman &
Werner, 2005, p. 46). Another Heneman & Werner example is that participation in a group
setting is diminished when the group is reliant on one another (2005, p. 47).

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WAYS TO MAKE MERIT PAY WORK
First, an appraisal should have a clear standard of performance evaluation. With this, the
connection between pay and performance isn’t lost. Snell and Bohlander say that bias are
formed in performance appraisals due to “lack of management training” (2005, p. 349). Proper
management training can solve this problem. Second, as previously stated, is aligning the merit
pay plan to a company’s objectives, then merit pay becomes a form of strategic compensation
(Snell & Bohlander, 2013, p. 396). Third, testing employees reactions to the merit pay systems.
In the Elmhurst Park District case study, McKinney, Mulvaney, Grodsky use a “trial run” for the
district’s employees to gauge employees reaction to their new merit pay plan (2013, p.489).
WORTH LOOKING INTO
An approach that is worth looking into is Pfeffer’s idea of evidence-based management.
Pfeffer states that it is “a way of thinking and being open to learning” (as cited in Hansen, 2008).
Essentially this is a research and development way of thinking. Pfeffer says, “In R&D, you go
into the laboratory, you experiment and you keep up with the research that you do” (as cited in
Hansen, 2008). This is an interesting approach and a logical one at that given that throughout
my research, almost every article stated that there’s not enough actual evidence out there to
support the idea that merit pay actually motivates employees to perform better.
SUMMARY
In the end, we have learned that there’s psychological and economic theories that
motivate companies to use merit pay plans. We also learn that the most logical approach to merit

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pay is the psychological theory approach. The reason for this is the closeness it resembles to
what merit pay plans look to achieve. Without clear and precise performance measurements,
then the tie to pay to performance is lost. We can test merit pay by gauging employees’
reactions to their company’s merit pay plans. Aligning a performance appraisal and merit pay
plan to a company’s objectives can ensure that these objectives end up being clear and concise.
Merit pay plans fail when the tie between pay and performance is lost. They also fail
when they are based on the assumption that it motivate employees. Another reason they fail is
when employee interest is lost.
CONCLUSION
The evidence-based approach is a logical approach as to find the actual reasons behind
why employees are motivated to perform better under merit pay plans. With this approach we
can use research to developed better assessments of the motivational factors to employee
performance. While using these improved assessments, we can most likely formulate an
effective merit pay plan.
The idea that what works for one may not work for another is something to take into
serious consideration. Consider the article The Challenge of Making Performance-Based Pay
Systems Work in the Public Sector, the private and public sector of the federal government view
merit pay systems differently (Schay & Fisher, 2013). Their results show that supervisors and
the higher the educational level and males all support the idea of pay-for-performance (Schay &
Fisher, 2013, p. 380). Their results also show that union members, minorities (except for

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Asians), women prefer a group incentive plan (Schay & Fisher, 2013, p. 380). Once again, what
works for one might not work for another and research should be done to further break down
these results to get the specifics of preferences so that merit pay plans can be used more
effectively.
References
Hansen, F. (2008). Merit-Pay Payoff? Workforce Management, 87(18), 33. Retrieved from
http://search.ebscohost.com/login.aspx?direct=true&db=f5h&AN=35348694
Heneman, R.L., & Werner, J.M. (2005). Merit Pay: Linking Pay to Performance in a Changing
World, 2nd Edition. Greenwich, Connecticut: Information Age Publishing.
McKinney, W.R., Mulvaney, M.A., & Grodsky, R. (2013). The Development of a Model for
the Distribution of Merit Pay Increase Monies for Municipal Agencies: A Case Study.
Public Personnel Management, 42(3), 471. doi:10.1177/0091026013495766. Retrieved
from http://search.ebscohost.com/login.aspx?direct=true&db=f5h&AN=90248814
Schay, B.W., & Fisher, S.F. (2013). The Challenge of Making Performance-Based Pay Systems
Work in the Public Sector. Public Personnel Management, 42(3), 359.
doi:10.1177/0091026013495770. Retrieved from
http://search.ebscohost.com/login.aspx?direct=true&db=f5h&AN=90247685

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References (continued)
Snell, S., & Bohlander, G. (2013). Managing Human Resources, 16th Edition. South-Western:
Cengage Learning.
U.S. Department of Labor. (n.d.). Merit Pay. Retrieved from
http://www.dol.gov/general/topic/wages/meritpay